likely use a release from risk approach. Whether you estimate
a market price for risk or measure the contract reflecting the
preparer’s view of the cost associated with the uncertainty of
the expected cash flows, we’d probably end up in broadly the
same place. I’m sure that sound methodologies producing sufficiently close value will emerge.
TORTOISE: [Perking up when margins are mentioned] Wishful thinking!
ACHILLES: Well, I’ve been accused of being an optimist regarding technology, so why not in this, too? Fair values are based
on financial economics, which has been proven in paper after
paper to provide an accurate depiction of prices in markets.
disclosure are mostly useless. We need to work to ensure that
straightforward metrics and benchmarks, like actual-to-expect-ed ratios for mortality, cost of default-to-credit spreads, and
loss-development triangles, are available whatever values are
used. Although users are smarter than some give them credit
for, who can blame them for being fed up with all the detailed
drivel that preparers sometimes feel compelled to provide.
Meaningful sensitivities and a clear and realistic description
of the risks undertaken are needed in which users interpret the
market and derive assumptions differently from the preparer.
Maybe actuaries can come up with something useful here!
TORTOISE: I really have to disagree with that one—you must
be reading only theoretical journals. As I’ve never seen the perfect market that financial economics is based on, behavioral
economics seems to me to be far superior.
TORTOISE: It would be great to leave it to the actuaries! But
I get concerned when I read that fair values are pro-cyclical.
That doesn’t sound good. I’ve been told that actuaries are supposed to act in a manner consistent with the interests of the
public. How can they stand for this?
ACHILLES: Well, based on my experience, practice eventually
catches up with a good theory. My guess is we’ll find a combination of the two economic frameworks that will provide more
power to both models.
ACHILLES: Yes, I’ve been told that markets can overshoot
in both directions, causing bubbles and financial crises. Although this is caused by a tendency to follow the leader (or be a
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TORTOISE: Well, I agree that more research into practical
applications of economic concepts is needed. But I’m not sure
that even I will live to see the day that there’s a grand unified
ACHILLES: Who cares about theories, anyway? I just care
about observations and practical approaches. Effective disclosure may be the key that promotes transparency and
consistency, although some argue that fair values are transparent by definition. Disclosure of risk margins should encourage
comparable results. Experience in some countries suggests that
convergence of results happens fairly soon after their introduction, as long as it is accompanied by effective disclosure. (Who
wants to be known as a low-margin company?)
TORTOISE: Come again? Now you’re claiming that as long as
we require phantom values to be valued and reported, even if
based on different interpretations, everything will be all right.
How does that promote transparency? I’m all for useful information, as long as it’s reliable. But if you simply include as part
of disclosure the amount of the margin and a description of the
actuarial models and assumptions used, nobody but actuaries
will understand the explanations.